Afford Anything - Ask Paula: I Spent Ten Years in School, and Now I’m Behind on Retirement Savings

Episode Date: May 13, 2019

#193: Lori is behind on retirement savings, as a result of being a full-time student for more than a decade. She makes good money and lives frugally, but she’s aware that she’s behind for her age. What should she do? Sierra wonders whether she should apply her savings towards paying off her mortgage or building investments. Jenessa plans to retire at age 35, and she’s wondering if the 4 percent withdrawal rule applies for such a long time horizon. Her friend swears that it’s designed to cover a 30-year retirement, not a 60+ year retirement. Is that correct? Jacqui is 24 and recently married. She’d like to open a 529 College Savings Plan for her future children, which she doesn’t plan on having for another 8 to 10 years. Should she do this? David is on-track to reach financial independence at age 50. He would like to start adding bonds to his taxable brokerage accounts. How should he manage this? Mikayla lives in Atlanta. Her employer gives her a stipend to use public transportation. This money can only be used for that purpose. She’s thinking of getting rid of her car so that she can start using public transit, and applying the cost-savings of getting rid of her vehicle into a downpayment fund for a future home. Should she do this? Former financial planner Joe Saul-Sehy and I answer these six questions on today’s episode. For more information, visit the show notes at https://affordanything.com/episode193  Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else, and that doesn't just apply to your money. It applies to anything in your life that is a scarce or limited resource, which could include time, focus, attention, energy, absolutely any limited resource that you need to manage. And so that leads to two questions. First of all, what's actually important to you? Second, how do you live that out on a day-to-day basis? Answering these two questions is a lifetime practice. There are no simple answers.

That is what this podcast is here to explore. My name is Paula Pant and I am the host of the Afford Anything podcast. With me today is former financial planner Joe Saul See-high to help answer questions that come from you, the community. Hey, Joe, what's up? Paula, you are up. I am. I'm up. I'm awake.

That is fantastic. It's always good when you wake up for another day, isn't it? Absolutely. Something to be grateful for. Especially when we get to spend time answering people's fun questions, which I love coming here to do. So thank you very much for the invite. Ah, this is this is the gratitude episode. Sweet.

All right, well, we are going to kickstart that with this first question that comes from Lori. Hi, Paula. My name is Lori, and I started listening to financial podcasts about a year ago. And although there are many good ones out there, I always come back to yours and Joe's stacking Benjamins. Thanks for making my commutes educational. I keep hearing about the benefits of starting early with retirement accounts and investing. I just turned 33 years old, and I miss. out on all the great years of putting money away in my 20s because it took 10 and a half years

of schooling to obtain my career. I was 29 when I finally graduated and starting having an income. I am married with two children and I make about $280,000 a year. My husband is daddy daycare and works part-time. We put 90% of his income into a 401k and I invest $2,500 a month into a non-qualified tax account, $1,000 a month into a more aggressive, less liquid investment account. I put an extra $1,000 towards my mortgage. I max out an HSA and we have $50,000 in a high interest savings account as well as about $20,000 in a regular savings account. I currently have $15,000 in a SEP IRA and I just maxed out a traditional IRA account this year as I don't have access to a 401k through my job. I paid off my student loans. I have no car payments or consumer debt. I donate 10% of my income to charity and I

consider myself to be fairly frugal. My question is, what else can I do to make up for lost time when I was still in school and couldn't invest. I would like to invest in real estate in the future, but I need to read more about that before I take the plunge. I hate feeling behind and I want my money to work for me. Help me catch up. Thank you so much. Lori, first of all, I absolutely love your question. You seem to be doing everything right. You're living on significantly less than what you make. You have what's clearly a very high savings rate. and you are maxing out every account that you are eligible for. So what can you do next?

Well, a couple of things come to mind. First of all, you mentioned that you have two children. You could consider opening a 529 plan or an ESA, an educational savings plan for your two children. That would give you access to additional tax-advantaged accounts that could be used to pay for your kids' educational expenses. That's one option. You mentioned rental properties or real estate investing. I completely agree with where you're standing on that in that it's a great option for the future, but of course you want to do your research, you want to do your due diligence before you go into that. In the meantime, you can open either a savings account, a money market account, or depending on the timeframe that you're thinking about even a bond fund or some other investment account that is conservatively invested in which you can store down payment money for an upcoming real estate purchase. Again, with the the idea in mind that the level of risk that you would want to take within that account would be

appropriate for the time horizon there. So that's another option for you. And then finally, good old fashion taxable brokerage accounts. I know that they don't get a whole lot of popular press because everybody loves having tax advantages, which is what you can get from a retirement account. But the great thing about taxable brokerage accounts is that you can tap that money whenever you want. Yeah, I like what you're saying about the flexibility brokerage accounts, because especially in Nerdville, where we live, people shy away from them, I think too much because I think we get too many questions about, uh-oh, I've got all my money in places that are locked up and I really need some flexibility. Where do I get it? And so I tend to be a big believer that things are going to

change in the future. We don't know what's going to happen and to have some good flexible money. beyond your emergency fund is a good idea. I don't really have anything to add there, Paula. What I didn't like about Lori's question. Fight words. Well, no, no, no, no, because I love Lori's question. I'm with you. She's doing a bunch of awesome stuff, but I don't like feeling behind.

I don't like feeling behind. And here is the way I think you get away from feeling behind, which is run the numbers on what your number is for financial independence. What's that going to take? and then build yourself milestones to get there. So I don't like it when I feel like I have to have this mad rush of activity and I have to get there today. There can be stepping stones toward that goal that help you sleep at night.

So knowing that, hey, I'm not going to be there today. I'm not going to be there tomorrow. But that 10 and a half years of schooling I did made it so that I could earn almost $300,000 a year so I can go on the attack. once I build those milestones, it gives me the security of knowing that this path is one that I'm going to be able to catch up in a hurry because, frankly, I believe without even doing those numbers that you will catch up in a hurry. Yeah, absolutely. And that's a very good point in that so much of the popular press within both personal finance space and the financial independence fire movement space, it always emphasizes starting when you're young. And although that's a great message, The unintended consequence of emphasizing that message so much is that people who start when they are a little bit older and older could mean 30s, 40s, even 50s, often panic because there are some people who are listening to this podcast right now who are thinking, okay, I'm 52 and I just began paying attention to my finances. and now that I've just begun, everybody is telling me that I should have started when I was 22, am I screwed?

So while I, you know, of course the message of start young is great, I don't want that to ever be interpreted as if you start one or two or even three decades later, then you're up the creek without a paddle, right? There are plenty of ways that you can have an absolutely amazing life, even when you're starting not in your 20s. And Lori, I think you're in a fantastic position given that you have that combination of high income and low expenses. I remember the first time, well, not the first time, but one time when I felt like things were spinning out of control and I was way behind. This was actually about productivity, Paula. I had so many things I had to do. And I had this meeting with my mentor and I told him, I said, I can't think about this long. term stuff because I have 57 things I have to do. And he goes, okay, take out your planner. And we took

out my planner and we actually plotted when I was going to do each of those things that was on my brain. I got caught up in a week. And it was only because of the fact that they were all swarming in my head that I felt that way. And I found this with clients that when I would sit down with a client, we'd actually build the plan. We'd build the roadmap. A lot of what I heard in Lori's voice about being fearful, about being behind went away and felt much more confident. And confidence, as you know, Paula, is a huge part of investing. It is a huge part of, especially when the market goes poorly, at some point, the market's going to have a big downturn, and your confidence is going to help you get through that. Yeah, the thing about confidence

is that it becomes a self-fulfilling prophecy. The more confident you are, oftentimes, the better results you end up getting, both in investing and in, for those of you who are listening, who are entrepreneurs, in running a business. Of course, everything in moderation, if you're overconfident, that leads to hubris and pride cometh before the fall. But confidence, tempered with humility, is an unstoppable force. And so I agree with you, Joe. Lori, I would encourage you not to think of yourself as behind because you spent the last 10 years investing, in an educational program that allows you to now make $280,000 a year. And you can, because you have low living expenses,

you can devote a huge chunk of that towards building your nest egg from this point forward. One last thing that I want to say is, and I didn't mention this as an option before, but this I would also include as an option, you mentioned that you're making additional payments towards your mortgage. I don't know what your personal risk tolerance is, but depending on your personal constitution, you might feel better about opening a taxable brokerage account and putting more money towards investments. Or you might sleep better at night just knowing that that whole darn thing is totally paid off.

So I'm not going to recommend one over the other, but I'll just open that up as another possible option. When in doubt, if you're not sure what else to do, you can't go wrong paying off your mortgage. Yeah. My last point here, Lori, is thank you very much for the kind words about our podcasts, but please don't let anybody know you learned anything from my show, Stacking Benjamin's, because you're going to ruin my reputation. So let's leave that between us. Joe, you have a podcast? That's weird. Doesn't everybody have a podcast? That's true. I saw this. Did you see that meme of the little placard outside of a bar?

And there's a line of people. And on the placard, it says, get back in line. I have a podcast too. Ha, ha ha ha ha ha. So thank you, Lori, for asking that question. Our next question comes from Jackie. Hey, Paula. My name's Jackie. I'm 24 years old. I recently got married and both my husband and I are working to become financially independent. We are eventually planning on having kids, but not for another eight to 10 years. For our financial situation currently, we're completely debt-free and are maxing out both our 401k and Roth IRA. And on top of that, we are working on building up some liquid cash for potential house down payment or maybe we'll use it for something else. We really haven't decided yet. Anyways, I want us to know what your thoughts were

on putting money into a 529 plan for our future kids. Since schools are so expensive, it would allow our money additional time to grow so we wouldn't have to actually put as much money in in the end. However, it feels like we're in a student loan bubble right now. Is the 529 plan still a safe option? What I mean by this is, is there a foreseeable way that money could be taken from us if we were to put our money in a 529 plan when the bubble burst? Thanks. Jackie, that's a fantastic question. And congratulations on your progress towards financial independence. Now, the first thing that you should know is that you cannot open a 529 plan for a hypothetical future person. In other words, you cannot open a 529 plan for a person who has not been born yet. in order to open a 529 plan and name a person as a beneficiary, that person needs to have a social security number and needs to be identifiable. Now, the workaround to this is that you can change the beneficiaries on a 529, which means that you could open up a 529 plan for yourself, and then when your children are born, change the beneficiary designation on that 529 plan into the name of the child.

But I want to clear that up up front because I've also looked into opening a 529 plan for my hypothetical future kids. And it turns out I can't do that, at least not without that workaround. So you could think of it as the backdoor 529 plan, so to speak, the backdoor beneficiary loophole. Yeah, there's another loophole that I'd like to talk about too, which I think is going to be important because early in a marriage especially, and you talk about having a house down payment, I like leaving the money. flexible. I love the idea, by the way, Jackie, of putting money away because, as Paula said, college costs are so expensive that starting early is never a bad option. But with so many other things and other priorities, I would leave that money. We talked earlier in the answer to a question about having a flexible brokerage account. I would stay flexible with that money now. And then once

the child is born and you are more clear on what the price is, priorities are and where college fits versus the house versus other things, I would then make what some people refer to as a mega contribution to a 529 plan. Here's the deal. There are these rules around gift taxes where you're only allowed to put so much money, give so much money to another person. Five 29 plans are subject to those rules. So there's a moving number every year where that's the top amount you can put into a 529 plan. However, most 529 plans and make sure this works with yours, most 529 plans allow you to use a five-year averaging number to put in five years worth of money and count it as if you'd made five years

worth of gifts to your child without paying any gift tax. So I would, or excuse me, there probably will be no gift tax lawyers out there. I get that. not having to file a gift tax return, which most people don't want to do. You don't want to file an extra return. So use that year where you can average five years worth of contributions to build up as much money as you want, then make a huge contribution at one time once your priorities are more clear. I think I'd go that way. And do you think that the advantage of making a mega contribution is batching, essentially, that you can preserve your flexibility prior to when the child is born,

And once that child is born, you take some of that flexible money and then lump sum it into the account? Especially when she says that she has a house goal as well. And we don't know how those two goals play against each other. So unless she already has supreme clarity, listen, this is not money I will ever, ever, ever use toward a house. And it's money I want to use toward education. And we also know, and this is horrible, but biology has something to do with this too, right? I mean, I worked with families, and it's a painful time where year in and year out, they just, they can't have children.

And they decide for whatever reason, maybe not to adopt a child. But if they know that if biologically, they don't have a child and they decide that they will adopt a child, and they know that's going to be the case for certain, go ahead and do it now. If you don't know those things and you want to wait, I think a lot of people aren't familiar that you can do this huge one-time. contribution and not have to file a gift tax return as long as it doesn't go above five years worth of contributions. Yeah, and that's a good point too, because in terms of when you look ahead at what some of your major expenses are going to be, of course, buying a home is a predictable major expense, perhaps replacing your car or making sure that you have a sufficient emergency

fund, those are all fairly predictable major expenses. But things that we don't know is, are you going to have to spend money on expensive IVF treatments. Those are all questions that are unanswerable until you are in that situation. Yeah, cost associated with adoption. Again, same thing. Yes, exactly. You know, for that reason, it can be extremely hard to predict what your expenses will be. And that is not always because your wants increase. Sometimes it's because life gets in the way. infertility happens, major unpredictable medical expenses that your insurance doesn't cover or only partially covers, those things happen. The need to take care of a family member unexpectedly. All of these things can disrupt even the best laid financial plans. So preserving that level of

flexibility, there is certainly something to be said for it. I remember when I found out that you could use this five-year rule and it really, it really made it nice for people that are in her situation. One other thing that I'll say with regard to paying for a child's education is if you purchase a home on a 15-year mortgage, a rental property on a 15-year mortgage, then if you purchase that home when the child is zero or one, then by the time that that kid is 15 or 16, the home is paid in full. And then all of the rental income from that home can, be used either as a the net rental income I should say after operating costs can be used

either to pay for college related expenses or the home can be sold and the proceeds from that sale can be used to purchase the cost of college or the home can be borrowed against and that home equity loan can be used to cover some educational expenses you have so many options when you have a home that's paid free and clear a rental property that's paid free and clear so that's another way that you can plan for covering educational expenses. And heck, if you're thinking ahead about a child that will be born 10 years from now, which means that they won't even be starting college until 28 years from now, you can buy that home on a 30-year mortgage. I was just expected to hear a mic drop after that. You just walk away. That's the end of the show.

Bam. You know how they say when all you have is a hammer, everything looks like a nail, You know, and when you're really into rental property investing, you see its application everywhere. It is. Yes. Got a toothache? Have you considered a rental property? You want to buy a McDonald's franchise? Here's what you do first.

Buy it 15 years from now. Take out a 15-year loan. So good. Thank you, Jackie, for asking that question. We'll come back to this episode after this word from our sponsors. Are you looking for a deodorant that's made without a bunch of scary ingredients? Native deodorant is filled with ingredients that you know about, like coconut oil and shay butter. It's formulated without aluminum, without parabens, and without talc.

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That's g-u-t-o.com slash Paula. Gusto.com slash Paula. Our next question comes from Janessa. Hey Paula, I had a quick question about the 4% rule. Now, you've talked about the 4% rule before. I know it's not perfect, but basically it centers around a debate my friend and I were having. My friend says that the 4% rule is meant to carry you through retirement, so only about 30 years until you run out of money. Whereas I was under the impression that the 4% rule would allow you to draw out 4% of dividends.

essentially forever. As I am planning to retire before the age of 35, that's kind of an important distinction to make. So if you could clarify that issue, maybe that's something you and Joe want to tackle together, I would love to hear your answer on that. Thanks. Janessa, your friend is correct. The 4% withdrawal rule is an idea that comes from something called the Trinity Study.

Now, the Trinity study is research that was done by professors, finance professors at Trinity University, and what they did was they looked at a portfolio that's 50% equities or stocks and 50% bonds or fixed income. And they looked at that 50-50 portfolio under a variety of conditions and tested to see the likelihood that that portfolio would withstand a 30-year retirement. So they ran what's called Monte Carlo simulations to test this 50-50 portfolio under a variety of market conditions. And what they found was that at a 4% withdrawal rate, then that 50-50 portfolio has a 90% probability of not running out of money over the span of 30 years. Now, when I say 4% withdrawal rate for the listeners who are wondering what that means, it means that in year one of retirement,

you withdraw 4% of that portfolio balance. And every subsequent year, you withdraw 4% adjusted for inflation. So if you have a $1 million portfolio, that's $40,000 in year one, and $40,000 adjusted for inflation every subsequent year. So Janessa, your friend is correct. The Trinity study was designed to look at a retirement portfolio over the span of 30 years, assuming that a person retires at age 65 and then dies at age 95. The Trinity study was not built to look at a portfolio that would have to last for 50 or 60 years. And that research hasn't been done, at least not in a way that is as conclusive as what the Trinity study has displayed. So it's true. Your friend is correct that this guideline that a lot of people in the fire community are using, which is the 4% rule, has never

been tested for a 60 year retirement. I'll say this, just based on the fact that she wants to be financially independent as such a young age, I'd throw it out the window just for that reason. I mean, and not just because it doesn't work for long periods of time, but also because I want to be much more certain than that, if I, then one little, uh, guideline or one multiplier, I think I want to build some, some charts. I want to build some, um, fairly robust projections. And I'm thinking about if she's working with a professional using something like a Monte Carlo simulation to see based on different withdrawal rates and different things that happen to me. Like if, if I put in different variables, how will it work? So I would run as many different simulations that I,

can so that I get a much better idea of exactly what my personal withdrawal rate should be for my personal retirement. And the funny thing is I say that I know people are driving down the road or they're on their run or their commute or whatever. And they're going, I don't want to do all that work. It really isn't that hard. Number one, it's seriously. It sounds hard.

It's not that hard. And then number two is if you want to make sure you're financially independent that early, it's worth it. It's so worth it. So many people, Paula, spend, there was a study done that showed that people spend more time planning their vacation than they spend planning their financial independence. And really, if I want that financial independence to be maybe not a permanent vacation, but it's enjoyable as a permanent vacation, I probably want to dig into those numbers a little bit. So I would throw out the 4% rule completely and get my hands dirty and dig in. Hmm. That's interesting. So I would take a slightly different approach. And this is why I have you on the show so that we can look at a question from a variety of different angles. I would question the application of the 4% rule in the instance in which a person like you, Janessa, is retiring at the age of 35, because the chances, the probability that from age 35 to age 95, you're not going to earn any other money, I think there's a very slim, like near zero chance of that happening. And so for an early retirement, I would look at it as a multifaceted mosaic. You might live on a portion of your portfolio, sure, but you're also going to be supporting your retirement through part-time work or maybe more meaningful but lower paying work than what you're currently doing. You'll probably be starting projects.

and trying different things, and that income is going to come in. Also, your cost of living is going to change pretty dramatically throughout the rest of your 30s and 40s and 50s. And that could go up or down, or it'll probably do both, right? When we project out our current living expenses, and I think that this is an issue that I see oftentimes in the fire movement is people look at their current living expenses and then base their fire number on that

because they make the assumption that if I'm currently living on 3,000 a month or 4,000 a month, then I will live on that amount forever. I would disagree with the premise that your expenses will go up with age. There are some people who argue that. That's not necessarily true. But I would say that your expenses fluctuate. Now, whether that's up or down, it'll probably be both at different points in your life. I would just say it this way.

I know your emotions are going to change your spending. and what's important today is not going to be important 20 years ago. Maybe it will be, maybe the fundamental guideline to be important, but things are going to change so much. And so I guess looping this back to what Janessa was saying, she was saying that she plans on reaching financial independence at the age of 35. And from the way that she's structured her question, given that she's asking about the 4% withdrawal rule, I assume that means that at age 35, she plans on quitting a job and living on an investment portfolio. which I think by most people's standards would be a version of retirement. But again, I just go back to, I don't think, A, that you're going to live on a retirement portfolio forever.

I just don't think you're going to live purely on investments from age 35 through infinity. And B, I don't think that you're never going to earn a penny again. And so as long as the 4% withdrawal rate can give you a red beans and rice existence, Janessa, then I say, that's cool. And then look to what you want to do once you leave your current day job, your 9 to 5. The reason I'm smiling is because just if you want a case study in this, I practice something called batching and I practice something else called free days. And I believe that you need this time, not a vacation, but time during your week to recharge. And once you're past the point of being able to work for your daily existence,

and you have the ability to take some time off, I believe that taking half a day off to a day off a week just to recharge your batteries and do stuff that makes you more rounded does two things. Number one, it makes you more responsible in the days that are left and you find yourself much more honed in on the task at hand versus just punching the clock and working long hours. So there's fewer wasted hours.

And the second thing is that in that day, you find that you get a lot of great ideas about work because you're not working. But what's funny is, the case study then is this. On one of my first free days, I decided I was going to play video games all day. Because I've always believed that if I could play video games all day, that would be like the perfect phenomenal existence. Like if I could quit my job and just pick up a controller and play video games, that'd be awesome.

And people are either going, Joe, that's really cool or Joe, you're an idiot. But let me tell you, let me tell you what happened. I got maybe two and a half hours in and I was so bored. I was so incredibly bored. And that was the first realization back in my 30s that this idea of planning for your, quote, retirement is more about taking this, taking enough time to really dig into what are you actually going to do? like what's what's the life I'm going to live and it's not just about even before retirement like i got the big aha then for before retirement because i thought this thing that i thought was so cool

two and a half hours later i'm like no i can't i can't do it which is another reason why i don't like using the 4% rule because the process of digging into the numbers and building these uh these scenarios uh the time that it takes to do that your mind starts thinking about what am i going to do with One modified way of looking at your withdrawal rate is rather than assuming a static withdrawal rate every year, regardless of what's going on in the market, you can also run the numbers as though you withdraw a higher percentage in the years in which the market is good and a lower percentage in the years in which the market has declined, so that that way you're not converting paper losses into real losses. So, for example, you could run the numbers as though you withdraw 4% when we have a strong economy, but then during a recession or during a bear market, you maybe only withdraw 2%. Here's the way I like doing that. I like actually setting static milestones.

And this is why it's not a plan. It's planning. I like setting static milestones of my portfolio needs to have at least X amount of dollars in it by the end of this year. So I've got this amount of money. And then when I get to that point, or I even get halfway to that point, I look at my portfolio, I take a look at that number, compare it to the number that my milestone says. If my milestone is behind, then I need to take one set of actions. If my milestone is ahead, I can take a different set of actions. So, let me give you an example.

Let's say that my portfolio has $15,000 in it that I didn't expect. I can make that big purchase. I thought that I might want. By the way, full well knowing that that also means that, if next year I don't meet my portfolio number, I'm going to have to take some drastic action next year, which brings up option two. I can just roll that over to the next year, meaning, okay, I know I'm 15,000 ahead. I'm building myself in more, more flexible room for the market to gyrate later on.

I can stay more aggressive with my investments. The third thing that I can do is I can just up every month, maybe take a little bit more out. So see, I have, because I know what that static number is, and I know how far a header behind I am, that then gives to me a bunch of criteria. And I know that as I'm even saying those, people are voting in their own head as you're listening. You're voting on which one of those you would have done. And my point back to you then would be, how do you know which one you would do unless you know what that static milestone is, which is why I get that number first. Exactly. So you're aiming for a target portfolio balance rather than a target withdrawal rate.

Absolutely. Yeah. Well, and your target withdrawal rate is going to be your target withdrawal rate. will be a part of that balance because you're going to assume that you're taking X amount of money out per year. But then that's going to change based on what actually happens in real life, which is never static. Right, exactly. And your need for that money is going to change depending on what you're doing in your life. If you quit your job at 35, there are going to be some years moving forward in which your earnings might be zero or 10,000 or 20,000. But there could also be years moving forward when you'll be working on some super cool project and you make 50,000 that year. So I wouldn't try to, I like what you said, Joe, about it's planning and not a plan. I wouldn't try to overplan because it is difficult to the point of nearly impossible to reasonably predict at the age of 35 what your lifestyle, your needs, your wants, your medical issues are going to be at the age of 50.

Absolutely. So thank you, Janessa, for asking that question. That sparked a great discussion. Our next question comes from Sierra. Hi, Paula. My name is Sierra, and I am 32 years old. I wanted to know if you could throw any advice our way. I'm debating if we should tackle our mortgage

or continue applying any extra money we have towards our savings. Right now, we currently owe $83,000 on our mortgage. We apply $2,100 a month towards our savings. savings. Today, my savings portfolio looks like this. We have $22,000 in our Roth 401k, $9,500 in a Roth IRA, in about $20,000 in savings, which also includes our emergency savings. Would you stop saving and apply the $2,100 towards your mortgage principal and paid off in two years, or should I just continue saving that money? I should add that $2,100 does not include the retirement funds that we save. Those are completely separate and we save about 20%

of our income to retirement. The end result would be to hopefully buy our first rental property this year. I know you're super busy, so no worries if you can't get back to me. I just value your opinion. Thank you. Sierra, so if your ultimate goal is to buy a rental property, then I would not focus on paying off the mortgage on your primary residence because assuming that you purchase this rental property with an investor loan, that investor loan is, number one, going to require a pretty significant down payment, typically between 25 to 30 percent. And number two, the mortgage rate, the mortgage interest rate on that investor loan is going to be higher than the mortgage interest rate on your personal primary residence. And so if you plan on taking out an

investor loan, then I would put as much money as possible towards the down payment on that rental property, even if that means going beyond the 25% to 30% required minimum down payment, right? So let's just say for the sake of example that one year from now, you have sufficient capital to make a 25% down payment on a rental property. You might put that $2,100 a month that you're talking about. You might put that towards a rental property so that you can buy it with an even bigger down payment, which means that when you take out a mortgage that's at a higher interest rate, you don't have to take out as much of a mortgage.

In other words, if you are going to have two mortgages simultaneously, it makes sense to direct your additional cash towards the one that has the higher interest rate, and that one is going to be the investor loan. Now, the exception to this would be if you plan on house hacking into that rental property. If you're house hacking, then you could purchase that rental property with a primary residence mortgage. That changes the game. But if you are going to do that, I mean, I still wouldn't rush to pay off your current primary

residence mortgage because you can have up to four primary residence mortgages at a time. So I might still use that money towards making sure that you have good cash reserves for this rental property, making sure that you have some wiggle room for repairs, maintenance, vacancies, all of the various expenses that come up when you buy another home. I think you'd nailed it there. You know, my whole thought process was it was only around using the money inside of your house if you did pay off the loan and you covered that just to get the interest rate down on the rental property. But without that, I look at just paying off a mortgage in general. If we take this

goal of the rental property out, throw that out the window and just say, do I pay off my house or do I keep saving? Because that's an interesting sub question of this, that we get often, which one's better. And the answer, I think, is there is no better. The first thing I would do is look and see, can you be okay both ways? Because if you're going to be okay toward your goal both ways, why not take the one with less risk, which is certainly paying off the mortgage. But if you're not going to be okay both ways, you're forced then into the mathematicians game of interest rates. And then we take the one that will get us the higher rate and based on an average investment in the stock market, you should, over long periods of time, expect that you can fairly easily beat your average mortgage payment rate. That being said, then I would say, forget about the mortgage and then apply all that money into something based on equities.

I like running through that though with people and asking them which one they like better. Because what's funny is emotionally some people like the mathematics game better and some people like the security better. And I think at that point, if you can do, but that's why I would do the math around, can I do it both? Because you might be forced into one game or the other one. And in this case, clearly, because of that rental property looming, I think it kind of forces your hand on which one's a better solution. Right, exactly. Yeah, I agree. that the rental property changes the equation, but I agree with you, Joe, if there was no

aspiration to buy a rental property, if we took that out of this question and just said, do I pay off my mortgage or invest? Largely it becomes math versus psychology, right? Mathematically, assuming that you have a long investment time horizon, assuming a time horizon of 10 years or more, then mathematically speaking, you can arbitrage the difference between the interest rate on your mortgage and the expected returns based on historical averages that you might get in an index fund. So mathematically speaking, that arbitrage would put you ahead or has a higher likelihood of putting you ahead. But psychologically, you know, paying off your mortgage might just help you sleep more easily

at night. And there's huge value to that as well. So if you take the rental property off the table, it becomes math versus psychology. And one way that you can figure out which side of the fence that you fall on for for people who are wondering that, everybody else who's listening to this question, who is wondering about how to apply this to their own lives, imagine that you had your home completely paid off. Would you take out a loan against that paid off home in order to free up cash that you could invest? Let's assume that closing costs were not a concern. We'll just wave

a magic wand and say that your bank is not going to charge you any closing costs on that loan. would you take out a loan against a paid off house to invest? That will give you your answer as to whether you feel more comfortable paying off your mortgage or investing that money. Thank you, Sierra, for asking that question. We'll return to the show in just a moment. Are you tired of getting nickel and dined by your bank? Are you looking for a bank that's going to pay you a high interest rate on a checking account while also not clobbering you with fees?

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Our next question comes from Michaela. I'm Michaela, currently living in Atlanta, Georgia. I just started a job three months ago with a software company. I make about $53,000 a year. I want to take advantage of any pre-tax account they have available because I want to buy a house soon. And I noticed that we have a transit account. I'm allowed to put the max of $265 a month.

It doesn't roll over, but if I don't use that full amount in the account, it stays there until I use it up. So it's pre-tax, and of course I want to take advantage of that, but I currently don't use public transit. And if I were to take public transit, taking the subway and the bus, it would not make a difference on my time getting to work. It would still take about an hour and 20 minutes. So I'm thinking maybe I should go ahead and get this account anyway to experiment with public transit and to also still get that pre-tax benefit of the account. I was thinking maybe I could Uber some days, Uber to the bus station, you know, use the bus station all the way there.

I don't know. See what's available to me. Do you think this is a good idea to experiment with? Because I do hate driving a lot and it does add stress to my life. And maybe this is a way out, even though my time getting to work isn't shortened at all. But someone else would be driving. It wouldn't be me. So I'd have time to do other things like think.

and read, stuff like that, eat. What do you all think? Thanks. Michaela, this is a fantastic question. My question back to you, if you were going to do this, if you were going to start commuting to work through public transportation, would you get rid of your car? Or would you keep your car so that you could still drive it to places other than work? Let's talk through both of those options. And let's start by exploring the option of selling your car and going everywhere with Uber,

the bus and the train. On the surface, I love the idea of selling your car, which means that you come up with a lump sum of cash right away from the sale of that car. Plus, you no longer have to pay for the car's maintenance, upkeep, depreciation, insurance, gasoline, so you save a bunch of money when you get rid of your car. It seems like, financially speaking, a big win. Here are a couple of hesitations that I have about it. You live in Atlanta, and I know having lived in Atlanta for five years, that Atlanta is not a very public transportation-friendly city. You know, if you live right on the MARTA line and you're going to and from the airport every day, then sure. But if you're trying to go anywhere else in Atlanta, particularly by bus, it's really hard. And for routine

to places where you regularly go, like when you go to work, it's relatively simple to develop a routine around that. My dad did that when we lived in Cincinnati and I was a little kid and he had to take the public bus to go to work every day. He developed a routine, right? So he knew exactly, I have to leave the house at X time of day in order to walk to the bus stop. And if I leave the house at X time of day, then I'll reach the bus stop at time Y, and the bus arrives at time Z, which means then I get to the office by time A, right? So he could develop a very clear routine with clear expectations because he was doing the exact same route at the exact same time five days a week. The challenge is when your sister asks if you can come over for dinner.

and all of a sudden there's this huge planning component of how do I get there and how far in advance do I need to leave, right? Or if you want to go to the dentist to get your teeth cleaned and you're not quite sure how to get there and then all of a sudden you're using all of these maps to map out your route and you have to make multiple bus transfers and then when you go to the dentist, they numb you and then you have to get back on the bus with like a drooling mouth. You know, it's just, it's such a pain to use public transit to go anywhere that isn't a routine when you're in an environment that is not public transit efficient or public transit friendly.

If you live near the beltline and you can reasonably ride your bike along the beltline to a lot of places to the grocery store, that's one thing. but if you live in a highly car-dependent suburb and you're relying exclusively on buses and the occasional Uber, it becomes a different calculation. And I'll say this also about relying on Uber and Lyft to get places. So I just went through this when I was in Austin, Texas, for five weeks. And for four out of those five weeks, I did not rent a car, the final week I did. But for four out of those five weeks, I relied on either Uber, Lyft, delivery, like grocery delivery, or occasionally being able to borrow friends' cars, I relied on

that to be able to get around. Now, for additional context, I was staying in an outer suburb. So my goal in being there was to hang out with my best friend and to help her with her new baby. So I Airbnb'd a place that was very close to her house, but I was in the outer suburb. So I was living in a car-dependent area without a car. While it was doable, it added this level of complexity to everything. that I did because if a friend contacted me and said, hey, do you want to get coffee? The first thing that would go through my mind is, can I borrow somebody's car at that time? And if the answer is no, then, all right, this person is suggesting that we get coffee at this location that is 15 minutes away.

That's going to cost me $20 round trip to get there and back. Do I want to pay a $20 cover charge to go meet this person for coffee, right? So when you separate, and this is actually a cognitive bias that Dan Ehrlich describes in the book Dollars and Sense, when you separate the pain of paying from the actual experience, then you often have a more pleasant time. So when it comes to having a car, you're still paying a bunch of money. It's just the experience of paying for that car and the insurance and the depreciation and the gas and the repairs and the maintenance and the oil changes, that experience is separated from

the drive to and from the coffee shop to meet your friend. And so you don't feel the pain of paying at the time that you go to the coffee shop for that meeting. But when you have to pay an Uber or a lift to go specifically to that coffee shop for that specific meeting and you know exactly what the admission fee to that coffee meeting is, it can be somewhat psychologically draining and it can have a impact in where you choose to go and how often you choose to go and who you end up meeting or hanging out with. As I hear that though, and I think about getting your teeth cleaned and your experience in Austin, I think about how this doesn't have to be an all or nothing thing, about how she could use public transportation, let's say, three days a week. And my initial thought

process is if she knows those are systematic days and there's not the thing that comes up during that day. That's cool. I mean, then her car lasts longer. She then doesn't have to pay so much money for her car maintenance or car upkeep. She ends up being able to invest that money or use it in other areas that she cares about. I love, by the way, the public transportation option. It sounds like it's going to take the same amount of time. Like she had a big deal talking about how the fact it wasn't going to take less time. I'm not about that. You know what I like? Back in the day when I had a commute. I just wish that I could be doing something else. And for me to have this time to be able to either study something or get some extra work done or whatever and somebody else is doing the

driving, this largely wasted time, I'm pretty geeked about claiming that time. So having somebody else do the, do the driving three days a week, avoiding that wear and tear on my car and getting away from the stress of driving those days while still having the car and the flexibility that Paula didn't have when she was in Austin. I love it. I totally agree with you, Joe. If you are trying to go somewhere using public transportation that is totally routine, that's actually pretty easy to do. So, Michaela, I would absolutely go to work and back using public transportation because that's going to be routine. You know exactly what time to leave the house, what time to get to the station, what time the bus or train leaves.

That can be an ironclad, this is my daily routine type of a thing. So for that, I would totally do it because then you save all the wear and tear on your car and then you can spend your commute doing other stuff. You don't have to drive there. That's great. But getting rid of your car entirely leads to a lot of other stresses in your life for those non-routine trips. Absolutely.

Yeah, but I'm with you, Joe. For going to work, man, yeah, totally take public transit to go to work. So great. Yeah. I mean, just that decompression time on the way home, the buildup on the way there, it's so good. Well, and it's so predictable, right? You leave your house at 730. You get to the stop at 740.

You board the bus at 745. You get to work by 9 o'clock, right? It's so predictable. Well, and while she's stressed out now sitting in traffic instead, she can be completely checked out until she gets there. I mean, she doesn't have to, she doesn't have to worry about. every stoplight along the way. Somebody else is doing that. Exactly. I bought a really inexpensive car with cash when we moved to Detroit. It was time for me to get a new car. And because

of the fact that it was going to be a car that like Michaela, I'm not going to use very often because I work from home. And I just needed some flexibility because the part of Detroit I live in doesn't have great public transportation either. You know, I was able to pay cash for an incredibly cheap car and do it with confidence because I know that I'm not going to drive it very much. I did a bunch of homework on the car and this car is going to last us a long, long, long time because I drive this thing twice a week, maybe. Nice. Yeah.

I guess it goes back to preserving flexibility, right? Yeah. Wow. We have a theme. Right? Yeah. It's the car equivalent of a taxable brokerage account. It's true.

That's what I call my, I call my, I call my. late model Saturn, well, there's no such thing as a current model Saturn view, but my car is my flexible brokerage account for... So thank you, Michaela, for asking that question. Our final question comes from David. Hi, Paul. This is David from Texas. I'm on track to reach FI at age 50 to 51, so about 11 to 12 years from now.

So I plan on doing a Roth conversion a lot, but not dip into those conversions at the five-year mark. So I daily like to wait until age 70. Most recommend VT Sacks in your tax bowl because it's tax efficient. But with a 9 to 10 year time frame until age 59 and a half, it's a long time to rely on a 100% stock portfolio. So I'm looking at using the bucket approach. So a question is, what's the most efficient strategy for tax purposes to start adding bonds into my tax bowl? Number one is go with VT Sacks until age 50 and then add bonds.

Number two is start adding bonds at age 45, then stare step it with one year of expenses until age 50. Three is contribute to Roth now with VBTLX and then not have access to its growth. Four is tax-free municipal bonds. So many options, but I just want another set of eyes on my situation. Also, are bonds and dividends from bonds tax at ordinary income tax rate? My portfolio right now would be close to about $2.5 to $3 million by age 50. So 20% bonds and 5% cash is what I'm comfortable with.

Spending level right now is at 65K, but I wanted to add that little buffer for a piece of mind. Thank you. David, thanks for the question. And I like the fact that you've really thought about this. And a lot of this, as you insinuate, is kind of going to be based on your preference. I know your question is more around tax savings,

but a lot of the time tax savings is in, the only factor. So I think that my answer has to be broader than maybe what you're looking for. So option number one that you gave us was to put all your money into VTSAX, which is the Vanguard Total Stock Market Index until age 50 and then add bonds. That you contrast with option two, which is start adding bonds earlier at age 45 and then stair step it with one year of expenses until 50. the move at age 45 is going to create more tax than the waiting until 50 option because of the fact that bonds, because of the way bonds make you money, the main way that you get cash also creates tax, unless, which is your fourth option tax for municipal bonds that we can get to later. So of those two options, starting at age 50 to add your bonds versus starting at 45, the age 50 option is going to have less tax.

Joe, let me just jump in here. The age 50 option will be more tax efficient, but from a risk management perspective, it means that he's not offsetting his investments with a bond allocation five years prior to when he retires. And that's when we start getting into the sequence of returns risk that financial planners warn about, right? If we have a financial downturn between his age 45 and age 50

and he stayed in versus having that bigger bond allocation, sooner, that's the risk. Exactly. Yeah, not answering his tax question, but yeah, there's going to be consequences of either decision. Exactly, exactly. So, sure, there will be a higher tax liability if you start adding bonds at the age of 45, but that might not be the thing to optimize for.

It might be that you want to optimize for having a portfolio that's aligned with your risk capacity and timeline to retirement. Yeah. Which for me, and I think I speak for you too, that's the bigger thing. Like, don't let the tax issue wag the dog. Tail wag the dog, yeah. Yeah, I would love to have Bill Gates tax bill. So, Joe, what do you think then of his third option, which is to start contributing to a Roth account now with a bond fund, with a Vanguard bond fund?

Well, the nice thing I like about that is that because bonds are going to be the least tax-efficient thing in his portfolio, that's a great place to put it because he still has access to the bonds inside of the Roth. And assuming that the Roth has been open for at least five years, right? He can just get at that. I can put it on Tuesday and take it back out on Wednesday. So assuming that, that he's five years into his Roth experience, then I would definitely take the least tax-efficient investments and stuff those inside of the tax shelter, leaving

stuff that is more tax efficient outside of the tax shelter. Right. And for the sake of everyone who's listening, who's wondering why a Roth account is more tax efficient, it's because contributions to a Roth account are tax exempt in their growth. So if you're contributing to a pre-tax account, then you don't pay the taxes in the year in which you make the income, but you pay taxes later on all of the growth that happens inside of that. In a Roth account, it's the opposite. If you contribute money to a Roth account, then you do pay taxes on that income in the year in which you make the contribution, but you are exempt from taxes on all of the dividends and capital gains, all of the growth. So that's why

putting a tax inefficient investment into a Roth account can make sense because the Roth account is a tax-exempt account. The fourth option here, tax-free municipal bonds, unless you're okay with a return that is not much above inflation, it is. It is. my least favorite. So if you are in portfolio maintenance mode and just more worried about taxes than growth, growth doesn't matter at all anymore, then tax-free municipal bonds are fine. You can, by the way, get some growth in tax-free municipal bonds, but much like you and I, cities also have credit ratings. And the way to get growth in tax-free municipal bonds, municipal, by the way, means that you are loaning money to cities, you have to find cities that have really bad credit

and low money to them. So much like you and I might have a low credit score, a city may have a low credit score, and the same risk applies. If you loan money to a city that has trouble paying their bills, they might default and you might not get your money back. But generally speaking, people don't do that. They like to put their money in safe municipal bonds when they choose that route. And if you're going to put your money in safe tax-free bonds, the return just isn't there if you need growth in your portfolio. David, lastly, you asked about bonds and dividends from bonds tax to ordinary income tax rate. That is correct, except if you purchase the bond at a discount and then the bond goes up in price, if you buy an individual bond, and it goes

up in price, goes up in value, either the time you sell it or the bond is called, you may then also pay a capital gain. So there might be a capital gain or a capital loss based on the price difference. But if you're generally speaking to the income from bonds, it's taxes, ordinary income. And that comes directly from our friends at Fidelity Investments, their learning center. I know that one, Paula, but I always like to make sure that we back it up with credible, incredible resources. So if you don't like that, go to fidelity.com. I like that, Joe. You're already heading off where the emails go. If you don't like it, email at stacking benjamins.com. And then I will tell you to emailfidelity.com.

And that actually brings up something very serious. Obviously, Paula and I are not tax advisors. Whenever you've tax questions, you should definitely talk to a CPA or a tax professional. and not us. I agree, yes. Don't believe everything that you hear on the internet. That is surprising. Yes. Yes.

That's always the disclaimer. None of this is professional advice. None of this is financial advice. None of this is legal advice. It's not tax advice. And we don't hold ourselves out to be anything other than just two total randos who happen to have access to the internet. Nerds who are entertaining ourselves and bringing you along for the ride.

Exactly. So thank you, David, for asking that question. Joe, I think we did it. I am tired, but I have that exhausted but happy feeling. Like we just ran five miles successfully. Well, thank you so much, Joe. Where can people find you if they would like to hear more of your wacky ideas? You can find me and all the wackiness that's the Stacky Benjamin show, Monday, Wednesday, Friday, the same place you're listening to afford anything.

And on Fridays, you'll also find my good friend Paula there as well on most Fridays. almost. I'd say what, what do you think? Probably three out of four Fridays a month. Yeah, yeah, about three out of every four Fridays. I'm usually on the show, ish. Yeah, yeah. And we have a lot of fun on those Friday episodes, answering trivia questions that nobody in their right mind would know the answer to. Well, thank you so much, Joe. And thank you for listening to this episode. If you enjoyed today's episode, please do three things. Number one, share this episode with a friend or a family member. If one of these questions reminded you of somebody who you know, if any of the situation sounded familiar, if you think that this could be helpful for a friend, a colleague,

a relative, share this episode with them. Number two, please hit subscribe or follow in whatever app you're using to listen to podcasts. And number three, please go to afford anything.com slash iTunes and leave us a review. That'll take you to the Apple Podcast page where you can leave us a review. and let the world know that you enjoy this podcast. Thank you again for tuning in. My name is Paula Pant. If you have a question that you would like answered on a future episode, you can leave that question at afford anything.com slash voicemail.

Thanks again for tuning in, and I'll catch you next week.